At this writing, America has undergone one of the most sweeping changes in bankruptcy law in its history. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was intended to cut the pace of personal bankruptcies by increasing filing costs, using income means testing in regards to liquidation and repayment, and requiring credit counseling.
The rush to file under the old law created the heaviest pace in personal bankruptcies in the country at more than two million petitions. And for a while, it seemed the chill would stick. But as 2006 progressed, the American Bankruptcy Institute noted that bankruptcy filings were starting to rise again.
Apparently, a nation that can’t seem to wean itself from credit can’t quite seem to wean itself from a court-assisted clean slate either.
Influence of total consumer debt on bankruptcy filing trends by year, 1980-2004
Households per consumer filing, rank during the 12-month period ending December 2005
The following two charts from the American Bankruptcy Institute are eye-opening just to see how prevalent bankruptcy has become in society during this new century.
The first shows how rising debt payments as a percentage of personal income have compared with bankruptcy filings nationwide. Yet the second chart, which shows the number of households per consumer filing in each state is even more of a shocker- to realize that one in every 34 households in the state of Indiana has filed for bankruptcy in 2005? Even though a significant portion of Indiana is rural, you could say that’s one household every four or five blocks in an average neighborhood.
On a national level, there was one personal bankruptcy for every 60 U.S. households, a 23 percent increase from calendar year 2004.
Six things that tip people into bankruptcy
A 2005 study by the University of Nevada at Las Vegas pointed out that hurricanes were actually a major force in bankruptcy filings, pointing out that filings in affected states increase by 11 percent in the 12 months after a major hurricane, up to 30 percent two years afterward, and up 46 percent three years afterward. It will be a valid issue to watch in the aftermath of Hurricane Katrina.
Obviously, not everyone lives in a major storm zone, but unexpected personal disasters are a primary culprit, and they take many forms:
Divorce. Today’s divorce rate is lower than it was in the 1980s, but it is still a major driver of financial disaster. Two people who once paid a monthly housing bill now need to pay two, on top of legal bills, new child care costs, and the possibility of alimony or child support payments that may put a strain on one or both spouses. Add that to the debt the combined household was already wrestling with, and the pressure for many quickly reaches the breaking point.
Serious illness. Nearly 40 million Americans have no health insurance of any kind, and while at other points in our history the numbers have been greater, the sheer cost of care tips many into bankruptcy. Various surveys report that more than 20 percent of all bankruptcy filers mention medical debt as the major contributor to their late payments.
Sudden unemployment. So many people live paycheck-to-paycheck.
The simple interruption of that income, even for a few weeks, could bring their debt and other expenses to a crisis.
Overuse of credit cards. Individuals with high revolving debt sometimes at rates as high as 20 percent are ripe for financial failure as soon as they lose a job or another major source of income. Simply, the rates for this type of borrowing are too high to be practical for most people.
Gambling. This is a controversial explanation, because most people who gamble do so responsibly. But some researchers believe there is a higher correlation between residents who live in casino states and those who don’t. Temptation to gamble irresponsibly, like the temptation to overuse credit cards, may occur where the best opportunities are to do so.
Getting the wrong advice. If you watch TV, you’ll see any number of ads on consumer credit counseling. There are reputable credit counselors-agencies that help you renegotiate debt payments and then ride herd to make sure you do it – but many more disreputable ones.
How Bankruptcy has changed?
As mentioned at the start of this article, the difficult decision to file bankruptcy became more stressful for individuals on October 17, 2005, when the Bankruptcy Abuse Prevention and Consumer Protection Act came into effect.
The most highly publicized aspect of the new law involved tough new restrictions is the most common form of individual filing that allows consumers to erase their debts.
Yet advisers say it’s important to understand one important fact-your own state laws might override certain parts of the new federal restrictions, making the payment and asset-retention outlook for debtors better or worse than they would be strictly under the letter of the federal law. That’s why it’s critical that potential filers get the advice of a qualified local bankruptcy attorney, a Certified Financial Planner, or a tax professional-sometimes all three.
Here are some basic questions to ask about filing for bankruptcy and how the new Law may affect the assets you have under your control:
What are the most important changes involving Chapter 7?
New federal requirements for the most popular category of individual bankruptcy-Chapter 7-now impose an income test (also known as a “means test”) that includes the following:
• If the debtor’s average monthly net income for 60 months is greater than $10,000, they won’t be able to file under Chapter 7
• If the debtor’s average monthly net income for 60 months is less than $6,000, then filing will likely be permitted
• Between $6,000 and $10,000, the debtor can file under Chapter 7 only if net monthly income is less than 25 percent of all non priority unsecured debts
Also, filers now have to supply proof that they’ve completed six months of credit counseling, preferably with a payment plan. These detailed reporting requirements will show if you were running up your credit cards before filing or acting irresponsibly in other ways.
Will documentation change?
Tremendously. Under Chapter 7 requirements, filers needed to file a relatively basic list of current assets and debts, a list of current income and expenses, and an overall statement of financial affairs. This has made things complicated. The courts want to see tax returns and detailed projections of earnings. They’ll want to see assets in retirement accounts and even educational accounts such as 529 college savings plans.
What about home-ownership issues?
If you want to use a new state as your domicile, you have to live there for 730 days. However, regardless of what state laws apply, the new bankruptcy act states that you must live in a home for 1215 days to get the state’s homestead exemption. Also, there’s a ten-year review period to determine if the debtor attempted to transfer money or equity into a homestead with the intent to hinder, delay, or defraud a creditor.
What about education savings?
All money held in a Coverdell education savings account or a section 529 college savings plan for more than two years is protected from payment of bankruptcy debts as long as the account beneficiary is a child, a stepchild, grandchild, or step-grandchild.